Chapter 4 The Balance Sheet

Individual Balance Sheet Accounts

3 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Assets Current assets include assets that are expected to be used within one year or the operating cycle, if longer –The operating cycle involves the use of cash to buy inventories, selling the inventory to create accounts receivable, and the collection of those receivables –In practice, one year is the common definition

4 Financial Accounting, 7e Stice/Stice, 2006 © Thomson The Operating Cycle Cash InventoriesReceivables CollectionsPurchases Sales

5 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Assets Cash includes coins and currency on hand; bank accounts; and short-term securities Accounts receivable are amounts owed by customers –An estimate of uncollectible accounts is deducted

6 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Assets Inventory represents goods held for sale in the normal course of business Prepaid expenses are payments in advance for operating expenses, e.g., insurance and rent Investment securities are publicly- traded stocks and bonds held with the intent to sell within a year

7 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Assets Current assets are listed on the balance sheet in the order of their liquidity, with the most liquid assets listed first

8 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Assets Expected to last longer than one year Common categories include –Investments –Property, plant, and equipment –Intangible assets –Other assets

9 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Assets Long-term investments include ownership of stocks and bonds to –Exercise influence over other companies (stocks) –Earn income from Interest (bonds) Dividends (stocks)

10 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Assets Property, plant, and equipment (PP&E) are fixed assets that benefit more than one accounting period –They include land, buildings, machinery, tools, furniture, and vehicles – Accumulated depreciation reflects the wear and tear since the original purchase and decreases PP&E

11 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Assets Intangible assets have no physical existence, but have some intrinsic value, generally from contract rights –Patents –Trademarks –Copyrights –Franchises –Goodwill only recorded when one company buys another and pays more than the fair value of the identifiable assets

12 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Assets The other assets category contains long-term assets not reportable under the previous categories –e.g., a deferred tax asset occurs when a loss or expense is recognized for financial reporting purposes, but will be deducted on the tax return in a later year

13 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Liabilities Obligations expected to be paid out of current assets within one year

14 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Liabilities Accounts payable are created when a company buys merchandise or supplies on credit Accrued liabilities represent expenses incurred (e.g., salaries, interest, taxes), but not yet paid

15 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Liabilities Short-term loans payable are formal, interest-bearing loans expected to be paid within one year The current portion of long-term debt is the portion of these liabilities expected to be paid within one year from the balance sheet date

16 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Current Liabilities Unearned revenue is the obligation to provide services to customers who have paid in advance

17 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Liabilities Long-term liabilities are obligations not expected to be paid or otherwise satisfied within one year

18 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Liabilities Long-term debt includes long-term notes, bonds, and mortgages Capital lease obligations represent leases of plant assets which are equivalent to debt-financed purchases

19 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Long-Term Liabilities Deferred tax liability: income tax expected to be paid in future years on income already reported on the income statement Pension obligations and other post- retirement obligations relate to a company’s promise to pay benefits after the employees’ retirement

20 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Stockholders’ Equity The residual interest in a corporation The owners’ paid-in capital can take the form of common stock or preferred stock

21 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Stockholders’ Equity Common stockholders –Have the most risk –Have the potential to reap the greatest return Common stock amounts are reported at – Par value (the amount printed on the certificates) – Additional paid-in capital (the amount paid above par)

22 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Stockholders’ Equity Preferred stockholders –Usually have a fixed return on their investment –Have fewer ownership rights than common stockholders Typically do not have voting rights –Have lower risk than common stockholders

23 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Stockholders’ Equity Retained earnings is the cumulative amount of profit that has not been distributed to stockholders as dividends Increased by – net income Decreased by – net losses – dividends

24 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Stockholders’ Equity Treasury stock: the company’s own shares that have been repurchased –The amount of treasury stock is subtracted from stockholders’ equity A company purchases treasury stock to –Show confidence in the value of the shares –Distribute cash to stockholders

25 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Accumulated Other Comprehensive Income Foreign currency translation adjustments –Arise from the change in equity of foreign subsidiaries as a result of changes in foreign currency exchange rates

26 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Accumulated Other Comprehensive Income Unrealized gains and losses on available-for-sale-securities –Unrealized gains and losses are fluctuations in the market prices of securities before they are sold – Available-for-sale-securities are those a company does not intend to sell in the short-run

27 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Accumulated Other Comprehensive Income Unrealized gains and losses on derivatives –Derivatives are financial instruments that derive their value from the movement of a price, an exchange rate, an interest rate, or an interest rate associated with another item

28 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Form of the Balance Sheet Side-by-side form –Assets on the left-hand side –Liabilities and owners’ equity on the right-hand side Columnar form –Assets, liabilities, and owners’ equity presented vertically

29 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Form of the Balance Sheet Current assets and current liabilities are listed by their liquidity Current assets and current liabilities are normally listed before long-term assets and liabilities Balance sheets are generally presented in a comparative format

30 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Foreign Balance Sheets PP&E is frequently listed first Current assets and current liabilities are frequently netted together as working capital

Recognition and Valuation

32 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Recognition Recognition: an amount is recorded and reported in the financial statements As an alternative, disclosure conveys financial information in the form of narrative notes

33 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Probable future sacrifice of economic benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events BALANCE SHEET ASSETLIABILITY EQUITY Residual interest in the assets of an entity that remains after deducting its liabilities

34 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Valuation Valuation is the process of assigning a value to an item once it is determined it should be recognized in the financial statements The value should be – Reliable: Independent parties can agree on the value and – Relevant: Reflects information that financial statement users care about

35 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Valuation Historical cost is an extremely reliable number Market value is an extremely relevant number The balance sheet reflects a mixture of different valuation methods –Market value is used when it is both relevant and reliable, e.g., investment securities

36 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Transaction Analysis The process of determining how an economic event impacts the financial statements A spreadsheet can be used to analyze the transactions of Veda Landscape Solutions based on the accounting equation: Assets = Liabilities + Owners Equity

37 Financial Accounting, 7e Stice/Stice, 2006 © Thomson 1)Veda invests $700,000 of her own cash in the business in exchange for all 10,000 shares of common stock.

38 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Assets = Liabilities + Equity Total assets $1,430,000 Total liabil & equity $1,430,000 Use this information to prepare the balance sheet

39 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Veda Landscape Solutions Balance Sheet January 1, 2006

40 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Asset mix is the proportion of total assets in each asset category –Generally differs by industry Retailers have lots of inventory Manufacturers have lots of PP&E Banks have lots of loans receivable Asset and Financing Mix

41 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Financing mix is the percentage of financing in each of two categories: –Liabilities –Equity It is reflective of management financing decisions rather than industry Asset and Financing Mix